Golden Leashes: Is Regulatory Intervention Warranted?

In the most recent volume of the Canadian Business Law Journal, Edward M. Iacobucci, Professor with the Faculty of Law at the University of Toronto, addresses certain arguments against dissident shareholders providing their director nominees with a future incentive if the target company’s share price increases following such nominee’s election to the board.1 These special compensation arrangements (or “golden leashes” as they are sometimes called) are hereafter referred to as “arrangements” and first emerged in Canada during the 2013 Agrium/Jana proxy fight, which was recently discussed by my colleague, Saeed Teebi, here.

Iacobucci explores some of the arguments for andagainst these arrangements and concludes that, on balance, they do not warrant regulatory intervention provided proper disclosure to shareholders is made.

Maximizing Shareholder Value – Opponents of these arrangements claim they encourage dissident nominees to focus on the short-term interests of the target company in order to maximize personal gain, and that such behaviour may ultimately result in the erosion of long-term shareholder value. Iacobucci argues, however, that these arrangements do not differ from more traditional stock-based incentive programs and that ultimately, a shareholder’s vote in favour of a nominee who has such an arrangement may imply that such shareholder has determined that the arrangement is value-enhancing for the company.

RecruitmentandSignalling – Agreeing to be a dissident director nominee can be a tough gig. Proxy contests can be lengthy public affairs and bitterly fought. The target company, media and other shareholders may go to great lengths to publicly undermine a dissident candidate’s ability and reputation. As a result, it can be difficult for a dissident to recruit highly qualified candidates to stand for election. Iacobucci considers that such arrangements (as opposed to an up-front cash payment) serve to provide dissident nominees with “skin in the game” and may signal to shareholders that the dissident slate is confident in its ability to maximize shareholder value. Positive signalling is a helpful tool in building a dissident nominee’s credibility.

Independenceand Conflicts of Interest– Detractors of these arrangements claim that they may compromise independence or create a conflict of interest by influencing the dissident nominee to carry out the nominating dissident’s plans for the company, potentially at the expense of the best interests of the company. Iacobucci claims that the independence argument is weak and that these arrangements may in fact support independence. He describes a counterfactual where a dissident nominee has been elected with and without an arrangement. A dissident nominee director owes his or her position on the board to the nominating dissident shareholder, but such director may have no financial stake in the success of the company; in this case, such director may be more inclined to implement the strategic vision of the nominating dissident shareholder. By contrast, the dissident nominee director with an arrangement has a financial incentive to ensure that the company is successful, regardless of the agenda or who is pushing it.

A further argument may be made that the use of these arrangements may give rise to a conflict of interest between the dissident director, the dissident shareholder who sponsored him or her (and who is generally paying for the arrangement) and the company. The issue comes down to who the director is really working for. Without dismissing the concern, Iacobucci considers that shareholders already have the power to ratify contracts or transactions where a potential conflict of interest arises between a director and the company, and so they should similarly be able to vote for a director who is “sponsored” by a dissident shareholder where such an arrangement exists, provided adequate disclosure of such arrangement is made.

Balkanization – Critics argue that since these arrangements result in directors on the same board receiving varying compensation, the board will become fragmented or dysfunctional. Iacobucci rejects this argument on the basis that, even in the absence of a proxy fight, differences in director compensation commonly exists and there has been no call to regulate unequal compensation among board members. Unless regulators intend on requiring that all companies adopt equal director compensation policies, it would be unfair to adopt specific rules in a proxy contest where such matters are essentially put to a shareholder vote in any event.

Iacobucci concludes by arguing that these arrangements are generally underappreciated and, further, that regulators should encourage adequate disclosure of such arrangements, but allow shareholders to make the determination of whether or not such arrangements are beneficial.

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